Question

If y increases from yo to yi then since gA = XYLT: gA will increase from gAo to gA1 gy will increase from 1.43gA to 1.43ga1 o But when y shocks up Lp shocks down and k > ks o k> ks dynamics kick in until steady state is achieved TIME (arbitrary) (Au

Q. For the Romer model depicted in the graphs on pictures:

Answer the followings:

1. Briefly summarize the economics behind the immediate drop in output per worker that accompanies each of the shocks depicted.

2. After the shock there is a very different response in the growth rate of output per worker: one is flat while the other has a very rapid recovery. Briefly summarize the economics of the Solow model that gives rise to these different shock responses.

Answer 1

1.

The long-run growth rate of output per worker in this model depends on positively on the following factors:

• The parameter λ, which describes the extent to which diminishing marginal productivity sets in as we add researchers.

• The strength of the “standing on shoulders” effect, φ. The more past inventions help to boost the rate of current inventions, the faster the growth rate will be.

2.

If the shock is transitory, initially, capital and output fall towards the low steady state. But when productivity reverts to the initial level, capital and output start to grow back towards the old high steady state.

• The effect of a prodictivity - The lines correspond to a transitory shock and a permanent shock.

• Taste shocks: Consider a temporary fall in the saving rate s. The function shifts down for a while, and then return to its initial position.